Senior loans, also known as bank loans or leveraged loans, are not entirely immune to the decline in the fixed income market this year. However, many of the exchange-traded funds dealing with this asset class perform worse than broader bond strategies.
This could signal an opportunity with the Virtus Seix Senior Loan ETF (SEIX). Senior Loans are generally lower quality pricing, but the asset class has performed well historically as interest rates rise due to its exposure to floating rate notes (FRNs). Indeed, rates are rising and this could enhance the short-term appeal of SEIX for income investors.
“Many investors are turning to bank loans, also known as floating rate loans, which are debt securities whose coupon is tied to a short-term interest rate such as LIBOR Where SOFR. Given the floating rate nature of the asset, adding bank loans to your portfolio can reduce duration and boost potential income as the Fed seeks to continue raising short-term interest rates to combat the recent surge in inflation,” according to BlackRock research.
For investors new to leveraged lending, the ETF wrapper offered by SEIX is relevant as it is a segment of the bond market that requires some training. In other words, investors considering SEIX should understand why this fund could be sustainable as rates rise.
“The ‘floating’ coupon feature reduces interest rate sensitivity for bank loans, which has contributed to the historical outperformance of asset classes against fixed income assets in rising rate environments,” added BlackRock. “The ‘float’ component of a bank loan resets periodically and will dictate when investors realize the benefits of rising rates. Coupon rates are initially set when a bank loan is issued, consisting of a benchmark interest rate (historically LIBOR and, in the future, SOFR) plus a credit spread.
SEIX, which celebrated its third anniversary in April, offers other advantages, including its status as an actively managed fund. While Senior Loans are acclaimed for their reduced interest rate sensitivity and high yields, critics are quick to point out potential credit quality and liquidity issues in this segment of the bond market.
As an actively managed fund, SEIX focuses on BB and B rated loans and can benefit from active management to avoid potential defaults while identifying higher quality value and credit opportunities. SEIX charges 0.57% per year, or $57 on a $10,000 stake.
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Opinions and predictions expressed herein are solely those of Tom Lydon and may not materialize. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.